This document discusses key concepts related to working capital management, including: 1. Working capital refers to a company's current assets and current liabilities. It represents the funds available to cover day-to-day operations. 2. There are two concepts of working capital - quantitative (total current assets) and qualitative (current assets minus current liabilities). 3. Proper management of working capital is important for business success as it allows companies to take advantage of opportunities and deal with challenges. Both too much and too little working capital can impair profitability.

1. Chapter-I
Working Capital Management
• Concept of Working Capital Management
- Current assets
- Current Liabilities
- Circulating Capital
• Structure of Working Capital
• Circulation of Working Capital
• Classification of Working Capital
• Importance of Working Capital Management
• Meaning of Working Capital Management
• Significance of Working Capital Management
• Difference between Working Capital Management and
the Fixed Assets Management
• Theory of Working Capital Management
• Factors influencing Working Capital Requirements
• Principles of Working Capital Management
• The Operating Cycle
• Duration of Operating Cycle
• Determinants of Working Capital
• Forecasting of Working Capital
• Control of Working Capital
• Adequacy of Working Capital
• Sources of Working Capital
• Structure of Working Capital
1

2. • The Present Study and Methodology
The uses of funds of a concern can be divided into two
parts namely long-term funds and short-term funds. The long –
term investment may be termed as ‘fixed investment.’ A major
part of the long-term funds is invested in the fixed assets.
These fixed assets are retained in the business to earn profits
during the life of the fixed assets. To run the business
operations short–term assets are also required.
Concept of Working Capital Management
There are two concepts of working capital viz.
quantitative and qualitative. Some people also define the two
concepts as gross concept and net concept. According to
quantitative concept, the amount of working capital refers to
‘total of current assets’. What we call current assets? Smith1
called, ‘circulating capital’. Current assets are considered to be
gross working capital in this concept.
The qualitative concept gives an idea regarding source of
financing capital. According to qualitative concept the amount
of working capital refers to “excess of current assets over
current liabilities.”2 L.J. Guthmann defined working capital as
“the portion of a firm’s current assets which are financed from
long–term funds.”3
The excess of current assets over current liabilities is
termed as ‘Net working capital’. In this concept “Net working
2

3. capital” represents the amount of current assets which would
remain if all current liabilities were paid. Both the concepts of
working capital have their own points of importance. “If the
objectives is to measure the size and extent to which current
assets are being used, ‘Gross concept’ is useful; whereas in
evaluating the liquidity position of an undertaking ‘Net
concept’ becomes pertinent and preferable.
It is necessary to understand the meaning of current
assets and current liabilities for learning the meaning of
working capital, which is explained below.
Current assets – It is rightly observed that “Current
assets have a short life span. These type of assets are engaged
in current operation of a business and normally used for short–
term operations of the firm during an accounting period i.e.
within twelve months. The two important characteristics of
such assets are, (i) short life span, and (ii) swift transformation
into other form of assets. Cash balance may be held idle for a
week or two, account receivable may have a life span of 30 to
60 days, and inventories may be held for 30 to 100 days.”4
Fitzgerald defined current assets as, “cash and other
assets which are expected to be converted in to cash in the
ordinary course of business within one year or within such
longer period as constitutes the normal operating cycle of a
business.”5
3

4. Current liabilities – The firm creates a Current Liability
towards creditors (sellers) from whom it has purchased raw
materials on credit. This liability is also known as accounts
payable and shown in the balance sheet till the payment has
been made to the creditors.
The claims or obligations which are normally expected to
mature for payment within an accounting cycle are known as
current liabilities. These can be defined as “those liabilities
where liquidation is reasonably expected to require the use of
existing resources properly classifiable as current assets, or the
creation of other current assets, or the creation of other current
liabilities.”6
Circulating capital – working capital is also known as
‘circulating capital or current capital.’ “The use of the term
circulating capital instead of working capital indicates that its
flow is circular in nature.”
Structure of Working Capital
The different elements or components of current assets
and current liabilities constitute the structure of working
capital which can be illustrated in the shape of a chart as
follows:
4

5. Structure of Current Assets and Current Liabilities
Current Liabilities Current Assets
Bank Overdraft Cash and Bank Balance
Creditors Inventories: Raw-Materials
Work-in-progress
Finished Goods
Outstanding Expenses Spare Parts
Bills Payable Accounts Receivables
Short-term Loans Bills Receivables
Proposed Dividends Accrued Income
Provision for Taxation, etc. Prepaid Expenses
Short-term Investments
Circulation of Working Capital
At one given time both the current assets and current
liabilities exist in the business. The current assets and current
liabilities are flowing round in a business like an electric
current. However, “The working capital plays the same role in
the business as the role of heart in human body. Working
capital funds are generated and these funds are circulated in
the business. As and when this circulation stops, the business
becomes lifeless. It is because of this reason that he working
capital is known as the circulating capital as it circulates in the
business just like blood in the human body.”7
Figure No.1 depicting ‘Working Capital Cycle’ makes it
clear that the amount of cash is obtained mainly from issue of
shares, borrowing and operations. Cash funds are used to
purchase fixed assets, raw materials and used to pay to
creditors. The raw materials are processed; wages and
5

6. overhead expenses are paid which in result produce finished
goods for sale.
The sale of goods may be for cash or credit. In the former
case, cash is directly received while in later case cash is
collected from debtors. Funds are also generated from
operation and sale of fixed assets. A portion of profit is used for
payment of interest, tax and dividends while remaining is
retained in the business. This cycle continues throughout the
life of the business firm.
6

7. Classification of Working Capital
The quantitative concept of Working Capital is known as
gross working capital while that under qualitative concept is
known as net working capital.
Working capital can be classified in various ways. The
important classifications are as given below:
Conceptual classification – There are two concept of
working capital viz., quantitative and qualitative. The
quantitative concept takes into account as the current assets
while the qualitative concept takes into account the excess of
current assets over current liabilities. Deficit of working capital
exists where the amount of current liabilities exceeds the
amount of current assets. The above can be summarised as
follows:
(i) Gross Working Capital = Total Current Assets
(ii) Net Working Capital = Excess of Current Assets
over Current Liabilities
(iii) Working Capital Deficit = Excess of Current
Liabilities over Current
Assets.
Classification on the basis of financial reports – The
information of working capital can be collected from Balance
Sheet or Profit and Loss Account; as such the working capital
may be classified as follows:
(i) Cash Working Capital – This is calculated from the
information contained in profit and loss account.
This concept of working capital has assumed a
7

8. great significance in recent years as it shows the
adequacy of cash flow in business. It is based on
‘Operating Cycle Concept’s which is explained later
in this chapter.
(ii) Balance Sheet Working Capital – The data for
Balance Sheet Working Capital is collected from the
balance sheet. On this basis the Working Capital
can also be divided in three more types, viz., gross
Working Capital, net Working Capital and
Working Capital deficit.
Classification on the Basis of Variability – Gross
Working Capital can be divided in two categories viz.,
(i) permanent or fixed working capital, and (ii) Temporary,
Seasonal or variable working capital. Such type of classification
is very important for hedging decisions.
(i) Temporary Working Capital – Temporary
Working Capital is also called as fluctuating or
seasonal working capital. This represents
additional investment needed during prosperity
and favourable seasons. It increases with the
growth of the business. ”Temporary working
capital is the additional assets required to meet the
variations in sales above the permanent level.”8
This can be calculated as follows:
Temporary Working Capital = Total Current Assets – permanent Current Assets
8

9. (ii) Permanent Working Capital – It is a part of total
current assets which is not changed due to
variation in sales. There is always a minimum level
of cash, inventories, and accounts receivables which
is always maintained in the business even if sales
are reduced to a minimum. Amount of such
investment is called as permanent working capital.
“Permanent Working Capital is the amount of
working capital that persists over time regardless of
fluctuations in sales.”9 This is also called as regular
working capital.
Importance of Working Capital Management
For smooth running an enterprise, adequate amount of
working capital is very essential. Efficiency in this area can
help, to utilize fixed assets gainfully, to assure the firm’s long-
term success and to achieve the overall goal of maximization of
the shareholders, fund. Shortage or bad management of cash
may result in loss of cash discount and loss of reputation due
to non-payment of obligation on due dates. Insufficient
inventories may be the main cause of production held up and it
may compel the enterprises to purchase raw materials at
unfavourable rates.
Like-wise facility of credit sale is also very essential for
sales promotions. It is rightly observed that “many a times
business failure takes place due to lack of working capital.”10
Adequate working capital provides a cushion for bad days, as
9

10. a concern can pass its period of depression without much
difficulty.
O’ Donnel et al. correctly explained the significance of
adequate working capital and mentioned that “to avoid
interruption in the production schedule and maintain sales, a
concern requires funds to finance inventories and receivables.”
The adequacy of cash and current assets together with
their efficient handling virtually determines the survival or
demise of a concern.11 An enterprise should maintain adequate
working capital for its smooth functioning. Both, excessive
working capital and inadequate working capital will impair the
profitability and general health of a concern.
The danger of excessive working capital are as follows:
Heavy investment in fixed assets – A concern may
invest heavily in its fixed assets which is not justified by actual
sales. This may create situation of over capitalisation.
Reckless purchase of materials- Inventory is purchased
recklessly which results in dormant slow moving and obsolete
inventory. At the same time it may increase the cost due to
mishandling, waste, theft, etc.
Speculative tendencies - Speculative tendencies may
increase and if profit is increased dividend distribution will
also increase. This will hamper the image of a concern in future
when speculative loss may start.
Liberal credit - Due to liberal credit, size of accounts
receivables will also increase. Liberal credit facility can increase
10

11. bad debts and wrong practices will start, regarding delay in
payments.
Carelessness - Excessive working capital will lead to
carelessness about costs which will adversely affect the
profitability.
Paucity of working capital is also bad and has the
following dangers:
1. Implementation of operating plans becomes difficult
and a concern may not achieve its profit target.
2. It is difficult to pay dividend due to lack of funds.
3. Bargaining capacity is reduced in credit purchases and
cash discount could not be availed.
4. An enterprise looses its reputation when it becomes
difficult even to meet day-to- day commitments.
5. Operating inefficiencies may creep in when a concern
cannot meet it financial promises.
6. Stagnates growth as the funds are not available for new
projects.
7. A concern will have to borrow funds at an exorbitant
rate of interest in case of need.
8. Sometimes, a concern may be bound to sale its product
at a very reduced rates to collect funds which may
harm its image.
Meaning of Working Capital Management
The management of current assets, current liabilities and
inter-relationship between them is termed as working capital
management. “Working capital management is concerned with
11

12. problems that arise in attempting to manage the current assets,
the current liabilities and the inter-relationship that exist
between them.”12 In practice, “There is usually a distinction
made between the investment decisions concerning current
assets and the financing of working capital.”13
From the above, the following two aspects of working
capital management emerges:
(1) To determine the magnitude of current assets or
“level of working capital” and
(2) To determine the mode of financing or “hedging
decisions.”
Significance of Working Capital Management
Funds are needed in every business for carrying on day-
to-day operations. Working capital funds are regarded as the
life blood of a business firm. A firm can exist and survive
without making profit but cannot survive without working
capital funds. If a firm is not earning profit it may be termed as
‘sick’, but, not having working capital may cause its
bankruptcy working capital in order to survive. The
alternatives are not pleasant. Bankruptcy is one alternative.
Being acquired on unfavourable term as another. Thus, each
firm must decide how to balance the amount of working
capital it holds, against the risk of failure.”14
Working capital has acquired a great significance and
sound position in the recent past for the twin objects of
profitability and liquidity. In period of rising capital costs and
scare funds, the working capital is one of the most important
12

13. areas requiring management review. It is rightly observed that,
“Constant management review is required to maintain
appropriate levels in the various working capital accounts.”15
Mainly the success of a concern depends upon proper
management of working capital so “working capital
management has been looked upon as the driving seat of
financial manaser.”16
It consumes a great deal of time to increase profitability
as well as to maintain proper liquidity at minimum risk. There
are many aspects of working capital management which make
it an important function of the finance manager. In fact we
need to know when to look for working capital funds, how to
use them and how measure, plan and control them.
A study of working capital management is very
important foe internal and external experts. Sales expansion,
dividend declaration, plants expansion, new product line,
increase in salaries and wages, rising price level, etc., put
added strain on working capital maintenance. Failure of any
enterprise is undoubtedly due to poor management and
absence of management skill.
Importance of working capital management stems from
two reasons, viz., (i) A substantial portion of total investment is
invested in current assets, and (ii) level of current assets and
current liabilities will change quickly with the variation in
sales. Though fixed assets investment and long-tem borrowing
will also response to the changes in sales, but its response will
be weak.
13

14. Difference between the Working Capital Management and
the Fixed Assets Management
In fact management of working capital is similar to that
of fixed assets management in the sense that in both cases a
firm analyses their effects on its profitability and risk.
However, fixed assets management and working capital
management differ in three important ways. Firstly, in
managing fixed assets time is very important. Consequently,
discounting and compounding aspects of time element play a
significant role in capital budgeting and a minor one in the
working capital management. Secondly, large holdings of
current assets specially cash, strengthen a firm’s liquidity
position (and reduce risks), but they also reduce overall
profitability. Thirdly, the level of fixed as well as current assets
depends upon the expected sales, but it is only current assets,
which can be adjusted with sales fluctuations in the short-run.
Theory of Working Capital Management
The interaction between current assets and current
liabilities is, therefore, the main theme of the theory of working
capital management. Working capital management is
concerned with the problem that arises in attempting to
manage the current assets, the current liabilities and the inter-
relationship that exist between them. The goal of working
capital management is to manage a firm’s current assets and
current liabilities in such a way that a satisfactory level of
working capital is maintained.
14

15. Factors Influencing Working Capital Requirement
Numerous factors can influence the size and need of
working capital in a concern. So no set rule or formula can be
framed. It is rightly observed that, “There is no precise way to
determine the exact amount of gross or net working capital for
every enterprise. The data and problem of each company
should be analysed to determine the amount of working
capital.
Briefly, the optimum level of current assets depends
upon following determinants.
Nature of business--Trading and industrial concerns
require more funds for working capital. Concerns engaged in
public utility services need less working capital. For example, if
a concern is engaged in electric supply, it will need less current
assets, firstly due to cash nature of the transactions and
secondly due to sale of services. However, it will invest more in
fixed assets.
In addition to it, the investment varies concern to
concern, depending upon the size of business, the nature of the
product, and the production technique.
Conditions of supply-- If the supply of inventory is
prompt and adequate, less funds will be needed. But, if the
supply is seasonal or unpredictable, more funds will be
invested in inventory. Investment in working capital will
fluctuate in case of seasonal nature of supply of raw materials,
spare parts and stores.
15

16. Production policy-- In case of seasonal fluctuations in
sales, production will fluctuate accordingly and ultimately
requirement of working capital will also fluctuate. However,
sales department may follow a policy of off-season discount, so
that sales and production can be distributed smoothly
throughout the year and sharp, variations in working capital
requirement are avoided.
Seasonal Operations-- It is not always possible to shift
the burden of production and sale to slack period. For example,
in case of sugar mill more working capital will be needed at the
time of crop and manufacturing.
Credit Availability-- If credit facility is available from
banks and suppliers on favourable terms and conditions, less
working capital will be needed. If such facilities are not
available more working capital will be needed to avoid risk.
Credit policy of enterprises-- In some enterprises most
of the sale is at cash and even it is received in advance while, in
other sales is at credit and payments are received only after a
month or two. In former case less working capital is needed
than the later. The credit terms depend largely on norms of
industry but enterprise some flexibility and discretion. In order
to ensure that unnecessary funds are not tied up in book debts,
the enterprise should follow a rationalized credit policy based
on the credit standing of the customers and other relevant
factors.
16

17. Growth and expansion-- The need of working capital is
increasing with the growth and expansion of an enterprise. It is
difficult to precisely determine the relationship between
volume of sales and the working capital needs. The critical fact,
however, is that the need for increased working capital funds
does not follow growth in business activities but precedes it. It
is clear that advance planning is essential for a growing
concern.
Price level change─ With the increase in price level more
and more working capital will be needed for the same
magnitude of current assets. The effect of rising prices will be
different for different enterprises.
Circulation of working capital─ Less working capital
will be needed with the increase in circulation of working
capital and vice-versa. Circulation means time required to
complete one cycle i.e. from cash to material, from material to
work-in-progress, form work-in-progress to finished goods,
from finished goods to accounts receivable and from accounts
receivable to cash.
Volume of sale-- This is directly indicated with working
capital requirement, with the increase in sales more working
capital is needed for finished goods and debtors, its vice versa is
also true.
Liquidity and profitability-- There is a negative
relationship between liquidity and profitability. When working
capital in relation to sales is increased it will reduce risk and
17

18. profitability on one side and will increase liquidity on the other
side.
Management ability ─ Proper co-ordination in
production and distribution of goods may reduce the
requirement of working capital, as minimum funds will be
invested in absolute inventory, non-recoverable debts, etc.
External Environment ─ With development of financial
institutions, means of communication, transport facility, etc.,
needs of working capital is reduced because it can be available
as and when needed.
Principles of Working Capital Management
The following are the principles of working capital
management:
Principles of the risk variation─ Risk here refers to the
inability of firm to maintain sufficient current assets to pay its
obligations. If working capital is varied relative to sales, the
amount of risk that a firm assumes is also varied and the
opportunity for gain or loss is increased. In other words, there
is a definite relationship between the degree of risk and the rate
of return. As a firm assumes more risk, the opportunity for
gain or loss increases. As the level of working capital relative
to sales decreases, the degree of risk increases. When the
degree of risk increases, the opportunity for gain and loss also
increases. Thus, if the level of working capital goes up, amount
of risk goes down, and vice-versa, the opportunity for gain is
like-wise adversely affected.
18

19. Principle of equity position─ According to this
principle, the amount of working capital invested in each
component should be adequately justified by a firm’s equity
position. Every rupee invested in the working capital should
contribute to the net worth of the firm.
Principle of cost of capital─ This principle emphasizes
that different sources of finance have different cost of capital. It
should be remembered that the cost of capital moves inversely
with risk. Thus, additional risk capital results in decline in the
cost of capital.
Principle of maturity of payment─ A company should
make every effort to relate maturity of payments to its flow of
internally generated funds. There should be the least disparity
between the maturities of a firm’s short-term debt instruments
and its flow of internally generated funds, because a greater
risk is generated with greater disparity. A margin of safety
should, however, be provided for any short-term debt
payment.
Operating Cycle
The duration of time required to complete the following
sequence of events, in case of manufacturing firm, is called the
operating cycle:
1. Conversion of cash into raw materials.
2. Conversion of raw materials into work-in-
progress.
3. Conversion of work in process into finished
goods.
19

20. 4. Conversion of finished goods into debtors
and bills receivables through sales.
5. Conversion of debtors and bills receivables
into cash.
The length of cycle will depend on the nature of business.
Non manufacturing concerns, service concerns and financial
concerns will not have raw material and work-in-process so
their cycle will be shorter. Financial Concerns have a shortest
operating cycle.
Operating Cycle of Manufacturing Concerns
20

21. Duration of the Operating Cycle
The duration of the operating cycle is equal to the sum of
the duration of each of these stages less the credit period
allowed by the suppliers of the firm. In symbols,
O=R+W+F+D–C
Where,
O = duration of operating cycle.
R = raw material storage period.
21

22. W= work-in-process period.
F= finished goods storage period.
D=debtors collection period, and
C = creditors payment period.
The components of the operating cycle may be calculated
as follows:
Average stock of raw materials and stores
R=
Average raw material and stores consumption per day
Average work-in-process inventory
W=
Average cost of production per day
Average finished goods inventory
F= Average cost of goods sold per day per day
D= Average book debts
Average credit sales per day
Average trade creditors
C=
Average credit purchase per day
Determinants of Working Capital
There are no set rules or formulas to determine the
working capital requirement of a firm. A number of factors
influence the need and quantum of the working capital of a
firm. These are discussed below:
Nature of industry– The composition of an asset is
related to the size of a business and the industry to which it
belongs. Small companies have smaller proportion of cash,
requirements and inventory than large corporations. Need of
22

23. working capital is thus determined by the nature of an
enterprise.
Demand of creditors– Creditors are interested in the
security of loans. They want their advances to be sufficiently
covered. They want the amount of security in assets which are
greater than liabilities.
Cash requirements– Cash is one of the current assets
which are essential for the successful operations of the
production cycle. Cash should be adequate and properly
utilized. A minimum level of cash is always needed to keep the
operations going.
General nature of business– The general nature of a
business is an important determinant of the level of the
working capital. Working capital requirements depends upon
the general nature and its activity on work. They are relatively
low in public utility concerns in which inventories and
receivables are rapidly converted into cash. Manufacturing
organisations, however, face problems of slow turn-over of
inventories and receivables, and invest large amount in
working capital.
Time- The level of working capital depends upon the
time required to manufacture goods. If the time is longer, the
amount of working capital required is greater and vice-versa.
Moreover, the amount of working capital depends upon
inventory turnover and the unit cost of goods that are sold. The
greater this cost, the larger is the amount of working capital.
23

24. Volume of sales– This is the most important factor
affecting the size and component of working capital. A firm
maintains current assets because they are needed to support
the operational activities which results in sales. The volume of
sales and the size of the working capital are directly related to
each other. As the volume of sales increases, there is an
increase in the investment of working capital in the cost of
operations, in inventories and in receivables.
Terms of purchases and sales– If the credit terms of
purchases are more favourable and those of sales less liberal,
less cash will be invested in inventory. With more favourable
credit terms, working capital requirements can be reduced as a
firm gets time for payment to creditors or suppliers.
Inventory turnover– If the inventory turnover is high,
the working capital requirements will be low. With good and
efficient inventory control, a firm is able to reduce its working
capital requirements.
Receivables turnover– It is necessary to have effective
control over receivables. Prompt collection of receivables and
good facilities for setting payables result into low working
capital requirements.
Business cycle– Business expands during periods of
prosperity and decline during a period of depression.
24

25. Consequently, more working capital is required during periods
of prosperity and less during the periods of depression.
Variation in sales– A seasonal business requires the
maximum amount of working capital for a relatively short
period of time.
Production cycle– The time taken to convert raw material
into finished products is referred to as the production cycle or
operating cycle. The longer the duration of production cycle,
the greater is the requirement of working capital. Utmost care
should be taken to shorten the period of the production cycle in
order to minimize working capital requirements.
Liquidity and profitability– If a firm desires to take a
greater risk for bigger gains or losses, it reduces the size of its
working capital in relation to its sales. If it is interested in
improving its liquidity, it increases the level of its working
capital. However, this policy is likely to result in a reduction of
sales volume and, therefore, of profitability. A firm, therefore,
should choose between liquidity and profitability and decide
about its working capital requirements accordingly.
Profit planning and control– The level of working
capital is decided by management in accordance with its policy
of profit planning and control. Adequate profit assists in the
generation of cash. It makes it possible for management to
25

26. plough back a part of earnings into the business and
substantially build up internal financial resources.
Activities of the firm– A firm’s stocking of heavy
inventory or selling on easy credit term calls for a higher level
of working capital than a firm selling services or making cash
sales.
Forecasting of Working Capital
To forecast the working capital requirement for the next
year the following formula may be used :
(Estimated cost of goods sold x Operating Cycle) + Desired
Cash Balance
Control of Working Capital
Working capital requirement depends upon the level of
operation and the length of operating cycle. Monitoring the
duration of the operating cycle is an important ingredient of
working capital control. In this context, the following points
should borne in mind:
1. The duration of the raw material stage depends on
regularity of supply, transportation time, price
fluctuations and economy of bulk purchase. For imported
materials it takes a longer time.
Example – X Ltd. Expects its cost of goods sold for the
forthcoming year to be Rs. 2 crore. The present operating
cycle of the firm is 78 days. The firm plans to reduce its
26

27. operating cycle to 73 days and desired cash balance is Rs.
5 lakh.
The expected working capital requirement would be,
73
2,00,00,000 x + 5,00,000 = Rs. 45,00,000
365
2. The duration of the work-in-process depends on the
length of manufacturing cycle, consistency in capacities
at different stages, and efficient coordination of various
inputs.
3. The duration of the finished goods depends on the
pattern of production and sales. If production is fairly
uniform throughout the year but sales are highly
seasonal or vice versa. The duration of finished goods
tends to be long.
4. The duration at the debtors stage depends on the credit
period granted, discounts offered for prompt payment,
and efficiency and rigour of collection efforts.
It is helpful to monitor the behaviour of overall operating
cycle and its individual components. For this purpose time
series analysis and cross section analysis may be done. In time
series analysis the duration of the operating cycle and its
individual components is compared over a period of time for
same firm. In cross section analysis the duration of the
operating cycle and its individual components is compared
with that of other firms of a comparable nature.
27

28. Adequacy of Working Capital
The importance of adequacy of working capital can
hardly be over-emphasized. John L. O. Donnell and Milton S.
Gladberg observe “Many a times business failure takes place
due to lack of working capital.”19 Hence, working capital is
considered as the life blood and the controlling nerve centre of
a business. Inadequate working capital is business ailment.20
Therefore, a firm has to maintain a sound working capital. It
should be adequate foe the following reasons:
(1) It protects a business form the adverse effects of
shrinkage in the values of current assets.
(2) It is possible to pay all the current obligations promptly
and to take advantage of cash discounts.
(3) It ensures, to a greater extent, the maintenance of a
company’s credit standing and provides for such
emergencies as strikes, floods, fires etc.
(4) It permits the carrying of inventories at a level that would
enable a business to serve satisfactorily the needs of its
customers.
(5)` It enables a company to extend favourable credit terms to
its customers.
(6) It enables a company to operate its business more
efficiently because there is no delay in obtaining
materials, etc., because of credit difficulties.
28

29. (7) It enables a business to withstand periods of depression
smoothly.
(8) There may be operating losses or decreased retained
earnings.
(9) There may be excessive non-operating or extraordinary
losses.
(10) The management may fail to obtain funds from other
sources for purposes of expansion.
(11) There may be an unwise dividend policy
(12) Current funds may be invested in non-current assets
(13) The management may fail to accumulate funds necessary
for meeting debentures on maturity.
(14) Increasing price may necessitate bigger investments in
inventories and fixed asset.
Source of Working Capital
Conventional generalizations relating to financing of
working capital suggest that an amount equal to the basic
minimum of current assets should be financed from long-term
source and that only seasonal needs of working capital should
be financed from short-term sources.21 It is obvious that such
an arrangement helps to keep the cost of working capital
finance to the minimum for an enterprise and gives a rise to its
rate of return on the total funds employed. Viewed thus, the
sources of working finance can be classified into permanent
and the current sources of working capital finance.
29

30. Structure of Working Capital
The study of structure of working capital is another name
for the study of working capital cycle. In other words, it can be
said that the study of structure of working capital is the study
of the elements of current assets viz. inventory, receivable, cash
and bank balances and other liquid resources like short-term or
temporary investments. Current liabilities usually comprise
bank borrowings, trade credits, assessed tax and unpaid
dividends or any other such things. The following points
mention relating to various elements of working capital
deserves:
Inventory– Inventory is major item of current assets. The
management of inventories – raw material, goods-in-process
and finished goods is an important factor in the short-run
liquidity positions and long-term profitability of the company.
Raw material inventories– Uncertainties about the future
demand for finished goods, together with the cost of adjusting
production to change in demand will cause a financial manager
to desire some level of raw material inventory. In the absence
of such inventory, the company could respond to increased
demand for finished goods only by incurring explicit clerical
and other transactions costs of ordinary raw material for
processing into finished goods to meet that demand. If changes
in demand are frequent, these order costs may become
relatively large. Moreover, attempts to purchases hastily the
needed raw material may necessitate payment of premium
30

31. purchases prices to obtain quick delivery and, thus, raises cost
of production. Finally, unavoidable delays in acquiring raw
material may cause the production process to shut down and
then re-start again raising cost of production. Under these
conditions the company cannot respond promptly to changes
in demand without sustaining high costs. Hence, some level of
raw materials inventory has to be held to reduce such costs.
Determining its proper level requires an assessment of costs of
buying and holding inventories and a comparison with the
costs of maintaining insufficient level of inventories.
Work-in-process inventory– This inventory is built up
due to production cycle. Production cycle is the time-span
between introduction of raw material into production and
emergence of finished product at the completion of production
cycle. Till the production cycle is completed, the stock of work-
in-process has to be maintained.
Finished goods inventory– Finished goods are required
for reasons similar to those causing the company to hold raw
materials inventories. Customer’s demand for finished goods
is uncertain and variable. If a company carries no finished
goods inventory, unanticipated increases in customer demand
would require sudden increases in the rate of production to
meet the demand. Such rapid increase in the rate of
production may be very expensive to accomplish. Rather than
loss of sales, because the additional finished goods are not
immediately available or sustain high costs of rapid additional
31

32. production, it may be cheaper to hold a finished goods
inventory. The flexibility afforded by such an inventory allows
a company to meet unanticipated customer demands at
relatively lower costs than if such an inventory is not held.
Thus, to develop successfully optimum inventory
policies, the management needs to know about the functions of
inventory, the cost of carrying inventory, economic order
quantity and safety stock. Industrial machinery is usually very
costly and it is highly uneconomical to allow it to lie idle.
Skilled labour also cannot be hired and fired at will. Modern
requirements are also urgent. Since requirements cannot wait
and since the cost of keeping machine and men idle is higher,
than the cost of storing the material, it is economical to hold
inventories to the required extent. The objectives of inventory
management are:
(1) To minimize idle cost of men and machines causes by
shortage of raw materials, stores and spare parts.
(2) To keep down:
(a) Inventory ordering cost.
(b) Inventory carrying cost,
(c) Capital investment in inventories.
(d) Obsolescence losses
Receivables – Many firms make credit sales and as a
result thereof carry receivable as a current asset. The practice of
carrying receivables has several advantages viz., (i) reduction
32

33. of collection costs over cash collection, (ii) Reduction in the
variability of sales, and (iii) increase in the level of near-term
sales. While immediate collection of cash appears to be in the
interest of shareholders, the cost of that policy may be very
high relative to costs associated with delaying the receipt of
cash by extension of credit. Imagine, for example, an electric
supply company employing a person at every house constantly
reading electricity meter and collecting cash from him every
minute as electricity is consumed. It is far cheaper for
accumulating electricity usage and bill once a month. This of
course, is a decision to carry receivables on the part of the
company. It may also be true that the extension of credit by the
firm to its customers may reduce the variability of sales over
time. Customers confined to cash purchases may tend to
purchase goods when cash is available to them. Erratic and
perhaps cyclical purchasing patterns may then result unless
credit can be obtained elsewhere. Even if customers do obtain
credit elsewhere, they must incur additional cost of search in
arranging for a loan costs that can be estimated when credit is
given by a supplier. Therefore, extension of credit to customers
may well smooth out of the pattern of sales and cash inflows to
the firm over time since customers need not wait for some
inflows of cash to make a purchase. To the extent that sales are
smoothed, cost of adjusting production to changes in the level
of sales should be reduced.
33

34. Finally, the extension of credit by firms may act to
increase near-term sales. Customers need not wait to
accumulate necessary cash to purchase an item but can acquire
it immediately on credit. This behaviour has the effect of
shifting future sales close to the present time.
Therefore, the extension of credit by a firm and the
resulting investment in receivables occurs because it pays a
firm to do so. Costs of collecting revenues and adapting to
fluctuating customer demands may make it desirable to offer
the convenience associated with credit to firm’s customers. To
the extents that near sales are also increased, extension of credit
is made even more attractive for the firm.
Cash and interest-bearing liquid assets– Cash is one of
the most important tools of day-to-day operation, because it is
a form of liquid capital which is available for assignment to
any use. Cash is often the primary factor which decides the
course of business destiny. The decision to expand a business
may be determined by the availability of cash and the
borrowing of funds will frequently be dictated by cash
position. Cash-in-hand, however, is a non-earning asset. This
leads to the question as to what is the optimum level of this
idle resource. This optimum depends on various factors such
as the manufacturing cycle, the sale and collection cycle, age of
the bills and on the maturing of debt. It also depends upon the
liquidity of other current assets and the matter of expansion.
While a liberal maintenance of cash provides a sense of
34

35. security, a lack of sufficiency of cash hampers day-to-day
operations. Prudence, therefore, requires that no more cash
should be kept on hand than the optimum required for
handling miscellaneous transactions over the counter and petty
disbursements etc.
It has not become a practice with business enterprises to
avoid too much redundant cash by investing a portion of their
earnings in assets which are susceptible to easy conversion into
cash. Such assets may include government securities, bonds,
debentures and shares that are known to be readily marketable
and that may be liquidated at a moment’s notice when cash is
needed.
The Present Study and Methodology
The importance of the study is emphasized by the fact
that as pointed out earlier in this chapter, the manner of
administration of working capital determined to a very large
extent, the success or failure of overall operations of an
enterprise. Many times, in the event of the failure of a business
concern, shortage of working capital is given out as its main
cause. However, in the ultimate analysis, it may be
mismanagement of resources of the firms that converted,
otherwise successful business into an unsuccessful one
“Inadequacy of working capital is a symptom, and sometimes
an excuse of business failure.”22 The proper management of
working capital is, therefore, of crucial importance, for the
35

36. success of an enterprise which involves the administration of
all current assets.
Methodology– There were many cement companies in
India. The annual reports of these companies have been
collected from financial statement data of companies given in
CMIE-Prowess-Database-Package. In addition, the author
visited some of the companies and discussed various issues
with the management of the respective companies. The
collected data have been analysed with the help of statistical
techniques and computer software. The analysis, findings,
conclusions and suggestions have been presented in the form
of this study.
Analysis of working capital methods– Various reasons
may make it essential to analyse the working capital position of
a business enterprise. One reason for analyzing the working
capital position of a company is to see what will be found
when financial statements are examined. A second reason is to
enable management to detect trends and take corrective steps
when the analysis indicates need for them. A third reason is to
see what changes have taken place in the company over a
period of time so that this knowledge may be used in setting
guidelines. There are two important tools for analyzing the
working capital position of an enterprise. One is the funds flow
analysis and the other is ratio analysis.
1. Funds Flow Analysis of Working Capital– This analysis
shows how funds have been procured for a business and
36

37. how they have been employed. This technique helps to
analyse changes in working capital components between
two data. The comparison of current assets and current
liabilities, as shown in the balance sheet at the beginning
and at the end of a specific period, shows changes in each
type of current assets as well as the sources from which
working capital has bean obtained. However, this
technique does not throw light on the question whether
the working capital is being used most effectively and
whether the current financial position of the enterprise
has improved.
2. Ratio Analysis of Working Capital– This is the most
commonly used technique which deals practically with
each and every aspect of working capital analysis. In this
technique, for each aspect of analysis certain ratios are
computed and then results are drawn on the basis of
trends shown by them against those fixed as guide–
posts. Various ratios are used in analyzing the various
aspects of the working capital position of an enterprise:
(a) Liquidity of Working Capital– An analysis of the
liquidity of working capital is of use for both the short-
term creditors and internal management or a business
enterprise. To the former it communicates - the chances
of receiving payment at the time of maturity, the margin
of safety, if the unexpected should arise which may
indicate whether the working capital is sufficient, the
37

38. extent to which a concern has over- or under-invested the
cash in its operating cycle. Two appropriate tests of this
important feature of the working capital analysis are to
be found in the computation of current and quick ratios.
The details of the current and quick ratios have been
discussed in the chapter where ratios have been
computed and analysed.
(b) Circulation of working capital– An analysis of
circulation of working capital highlights the
efficiency which working capital is being utilised.
For this purpose various turnover ratios such as
inventory turnover ratio, Receivables turnover
ratio, cash turnover ratio etc. are calculated which
show efficiency of the use of working capital in
each or its components as well as on the whole.
Generally the higher the level of these turnover
ratios, the smaller would be the working capital
requirements of an enterprise. The details of the
above ratios have been given in the respective
chapters.
This aspect of the analysis of working capital
focuses on the level of working capital. It helps an
analyst to know whether the size of working capital
maintained by an enterprise is excessive or short of
or adequate to its requirements.
38

39. Various ratios can be computed to know the
sufficiency of the size of working capital and
movements in the quantum of working capital in
successive periods. The two most important tools in
this connection are the computation of the size of
working capital in terms or “months’ cost of
production” and “months’ average sales turn-
over.” The results of these ratios when compared
with the quide-posts (as prevailing in the enterprise
or in the industry), show whether the size or
working capital maintained is of sufficient,
inadequate or of an excessive order. A comparison
of working capital with other variables such as the
output and sales over various years may also give a
hint to an analyst about the trends in the growth of
working capital. The use of index numbers,
percentages and ratios may help to accomplish this
task.
Scope and Purpose of Present Study
The present study “Working Capital Management in
Cement Industry In India” analyses the efficiency of the
working capital management and its components i.e. inventory
amount, cash and bank balances and various current liabilities.
The study attempts to determine the efficiency and
effectiveness of management in each segment of working
capital. Since the net concept of working capital has been taken
39

40. in the present study, management of both current assets and
current liabilities will be critically reviewed
The importance of the study is emphasized by the fact
that the manner of administration of current asset and current
liabilities determined to a very large extent the success or
failure of a business. The efficient and effective management of
working capital is of crucial importance for the success of a
business, which involves the management of the current assets
and the current liabilities. The business concern has therefore
to optimize the use of available resources through the efficient
and effective management of the current assets and current
liabilities. This will enable to increase the profitability of the
concern and the firm could be able to meet its current
obligation will in time.
Hypotheses of the study
The study has been pursued to test the following hypotheses
with reference to Cement Industry in India:
1. That proper management of working capital improves
both ‘Liquidity and Profitability’ position of a business
firm.
2. That external sources of finance particularly bank
borrowing are being liberally utilized in financing the
working capital requirement of industry in India.
40

41. 3. That the scope for improvement in the management of
working capital is greater in inventory as well as
receivables management than in cash management.
4. That the private sector of the industry is definitely in a
better position than the public sector, as far as
management of working capital is concerned.
We often start with as assertion or a hypothesis and use
our research data to prove or to disprove it. Every hypothesis
put to test with know statistical procedure and unless such
tests are carried out a research is not complete.
Objectives of the study
The present study has been undertaken to achieve the
following objectives with regard to management of working
capital in Cement Industry of India:
1. To analyze and evaluate working capital management of
selected units.
2. To evaluate the inventory, receivable and cash
management performance
3. To assess the relative significance of various sources of
financing of working capital.
4. To compare the selected units of the private sector
regarding management of working capital.
5. To suggest on the basis of conclusions, innovation in the
management of working capital in Cement Industry in
India.
41

42. 6. To find out the fluctuations arising in working capital in
various cement companies due to its nature of demand
and supply, production, government policies thereto.
7. To analyse the growth in the sector of production and
installation policies and capacities during five year plans.
8. To analyze the impact of cement industry on the national
economy.
9. To analyze new technique in cement industry with a
view to cutting costs and increasing efficiency in
production and distribution so as to raise the level of
production and consumption.
10. To know the profitability of cement industry and its
impact on working capital.
Methods of Study
In the present study, top five cement companies have
been selected out of more than 50 cement companies in India.
These companies are:
(i) ACC
(ii) Gujarat Ambuja
(iii) Shree Cement
(iv) Indian Cement
(v) Mangalam Cement
As the case study of five companies, the company will be
selected on the basis of capital employed. Obviously, it will be
a comparative study through empirical methods of the study.
42

43. Simultaneously, interview of top official in these companies
would be arranged to make the empirical aspect more
meaningful. It is expected that direct interviews may provide
insight into the practical and behavioural aspect of the
management of working capital, as the management is
basically a human problem. That is why interviews have been
planned in the course of study.
Besides these empirical methods of study, a histro-
descriptive method would also be used in order to make the
study academically significant and practically important
exercise.
The data relating to management of working capital of
cement industry and its selected units has been collected from
the published annual reports of the companies for the year
2003-04 to 2007-2008 which were directly obtained from the
registered offices of respective companies. In addition to this
primary data about practices, policies and procedures followed
in the management working capital in the selected units have
been collected through personal discussions with the top
executives of the units. This data was supplemented by
information collected from various books, journals,
newspapers and articles relating to industry. With the help of
data related to the study, various selected statements and ratios
have been calculated, fund flow and cash flow statements have
been prepared and interpreted through different statistical
techniques analysis of variance, coefficient of correlation and
43

44. regression etc. With the help of conclusions drawn, suggestions
have been presented to improve the efficiency of management
of working capital in the industry.
In the course of analysis in the study, use of various
accounting and statistical techniques have been made.
Accounting technique includes ratio analysis and funds flow
statement.
Ratio Analysis– The purpose of the ratio analysis has
been three-size analysis, composition analysis and efficiency
analysis. Various ratios computed in order to analyse the size,
composition and circulation of working capital and its various
components (Inventory, receivable and current liabilities) have
been explained at the relevant places in different chapters.
(i) Arithmetic mean– It gives a single value to describe
the whole data. Adding the value of all observations
and dividing it by the numbers of observations have
obtained simple arithmetic mean of each series of
different ratio.
(ii) Chi-square test– If the calculated value of Chi-square
exceeds the tabulated value at .05, it indicates that the
difference between Chi-square and ╧ is significant at 5
percent level, if exceed. 01 values, significant at 1
percentage level. If less than .05, is not significant.
(iii) Trend Indices– In order to measure the change in the
relative proportion of various components of the
44

45. working capital to the total such indices have been
computed.
(iv) Linear Regression Analysis: To make projection of
dependent variables (such as working capital,
inventory, receivables and cash) for a given value of
independent variables (sales) possible, the linear
regression equations have been used. Further, in this
type of analysis the value of Chi-square have been
computed in order to ascertain the closeness of the
relationship between dependent and independent
variables.
References:
1. Adam Smith, The Wealth of Nations, (New York, Modern
Library Inc., 1937), pp.262-263.
2. H.G. Guthman, Analysis of Financial Statements (New
York, 1953), p.63
3. R.D. Kennedy and McMullen, Financial Statements – Form
Analysis and Interpretations, (1968), pp. 265-266.
4. Parasanna Chandra, Financial Management Theory and
Practice (New Delhi, McGraw Hill Publishing Company
Ltd., 1984), p.260.
5. V.L. Gole, Fitzerald’s Ananysis and Interpretation of
Financial Statement.
6. Ibid., p.51
7. N.P. Agarwal, op.cit., pp.171-172.
8. Ibid.
9. Bentone E. Cup., Principles of Financial Management, (New
York, John Wiley & Sons, 1983), p.418.
10. O’Donnel and Milton S. Goldberge, Accountants Financial
Administration, (New Delhi, Prentice Hall of India Private
Ltd., 1964), p.55.
11. Ibid., p. 56.
12. K.V. Sith, op.cit., p.55.
45

46. 13. Ibid., p. 419.
14. Ibid.
15. E.F. Dolandson, Corporate Finance, (New York, Ronald
Press Company, 1956), p. 479.
16. K.V. Kulkarni, Financial Management, (New Delhi,
Himalayan Publishing Hosue, 1983), p. 399.
17. The term ‘technically solvent’ may be defined as the
ability of a business to meet its current liabilities duly as
and when they become due.
18. Guthmann. H.G. and Dougall, H.E., Corporate Financial
Policy, (Prentice Hall, New Delhi), Fourth Edition, p. 61.
19. John L.O. Donnell and Milton S. Galdberg, Elements of
Financial Administration, op.cit., p.55.
20. D.L. Thomas Keens, Business Accounts and How to Real
them in Studies in Accounting, (New York: W.T. Baxter,
Sweet and Maxwell Ltd. 1950), p.88.
21. C. Richard Osborn, Corporation Finance, (New York:
Harper & Brothers, 1969(, pp. 353 and 371.
22. M.H.B. Abd El-Motaal, Working Capital : Its role in the
short-run Liquidity Policy of Industrial Concerns’,
Accounting Research, Vol.IX, 1958, p.266
46